Valuing investment projects under interest rate risk: empirical evidence from European firms

In this article, we perform an empirical investigation of the effect of the interest rate uncertainty on the valuation of investment projects. The analysis is carried out by employing a real option approach and by considering a set of firms that operate in various production sectors in the euro area...

Full description

Saved in:
Bibliographic Details
Published in:Applied economics 2017-12, Vol.49 (56), p.5662-5672
Main Authors: Ballestra, Luca Vincenzo, Pacelli, Graziella, Radi, Davide
Format: Article
Language:English
Subjects:
Black-Scholes
Economic analysis
Economic models
Economic theory
Interest rate risk
Interest rates
investment project valuation
Investments
Real option
Real options analysis
stochastic interest rate
Stochastic models
Time series
Uncertainty
Valuation
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:In this article, we perform an empirical investigation of the effect of the interest rate uncertainty on the valuation of investment projects. The analysis is carried out by employing a real option approach and by considering a set of firms that operate in various production sectors in the euro area. In particular, the revenues generated by the investment projects are modelled using a geometric Brownian motion, whereas the interest rate is specified as a stochastic process of Vasicek type. Moreover, using the volatility of the equity return as a proxy, the volatility of the revenues is calibrated to real firm data, while the parameters of the interest rate model are estimated by fitting the Euribor time series. To this aim, an ad hoc calibration procedure is developed which is based on the maximum likelihood principle and thus has the merit of being simple, fast and suitable for practical purposes. Our study reveals that the interest rate uncertainty reduces the valuation of investment projects. However, stochastic interest rates do not provide a substantial improvement with respect to constant interest rates, or at least the differences are not statistically significant.
ISSN:0003-6846
1466-4283
DOI:10.1080/00036846.2017.1327120